China’s Shark Loan Ponzi Finance- Understanding China’s Shadow Banking System

From China's Shark Loan Ponzi Finance- Fitch Reports That the Size the "Trust Fund" Credit Growth is 28% of the Total Market Credit Growth:

A new report came out of Fitch Yesterday, stating that Informal Securitization is increasingly distorting credit Data, and has been under representing the actual amount of new loans in the first half of 2010: "Adjusted for informal securitization activity, Fitch estimates that the net amount of new CNY loans extended in H110 was closer to CNY5.9trn, or 28% above the official figure of CNY4.6trn...

So what exactly is Fitch referring to when mentioning “Informal Securitization”?

The trust products that Fitch is referring to are investment products that are sold by the banks, and packaged by the trust companies. There are two kinds of trust products, the first being products that are sold by the bank to local investors and represent loan that the bank has made directly to homebuyers. In fact, a lot China’s local government debt were packaged in as well. Up until two years ago most of the products were of this nature.

The second type started to be popular at the later part of 2009. In essence, this type is a high interest loan (often 15% plus annual rate) to real estate developers. Since the real estate developers have difficulty to raise funds through offering, they began to work with the banks in order to sell these products. The 10 fold growth in trust products that Fitch referred to came mostly from these kind of loans.

The marketing of the products is not very honest to say the least (who said China doesn’t import anything from America), and many buyers believe that they are guaranteed by the bank. But in reality, they are lending money to high risk new real estate projects.

The shark loan industry is mostly underground, and it’s sources can be low interest loan from banks, cash from state owned enterprises, and private savings. The shark loan operator then lends the money out to real estate developers or other domestic private firms.

There are two major pourposes for shark loans. One is to flip flop the real estate, and another is to lend to private firms with maturing bank loans. As mentioned in previous posts, the common lending practice of Chinese banks has a maturity of one year, and so the borrowers need to renew the loans every year if the old loan are to be paid. So many private firms that can’t pay back their loans since the cash flow from their regular business will not be enough to pay back the principal, are borrowing from shark loan operators at extreme high interest rates with very short durations. They then turn to the bank, repay the old loan and get a new loan for the next year.

Every day there are more and more real estate developers and other businesses that are resorting to loan sharks to manage through the hard times .But this is a short term solution for a long term problem. And like every drug addict, one day comes rehab or death.

If the real estate market remains stagnated for long enough, or if the banks stopped to issue new loans at an ever accelerating pace, many businesses will collapse. Even today, some relatively tight lending standards are causing some ponzi schemes to collapse, like the one of Tang long.


A larger percentage of China’s real estate sales are in reality fake since they are made with the purpose of obtaining the flow of bank loans before real sales happen. Through this arrangement, the developer and the shark lender make sure that the bank will bear the ultimate risk.

Western investors doubt this criminal activity since they do not understand the true nature of China’s society, or any totalitarian regime for that matter. But China is not a democracy; it is semi communist, semi fascist regime that is running a planned economy. All the banks are state owned, and as I mentioned in The Harsh Reality behind China’s Growth Story:

The root of the problem is the same: more loan growth can benefit the borrower, the banking executive, and the local government officials. The return of capital and the potential loss of the principal is always a secondary consideration, especially when the loan are issued to the state owned enterprises or well connected “too big to fail” private businesses. Who cares? The banks are state owned banks, and the capital is state capital.



I have explained the principal of these operations in the secret engine behind China housing bubble- China’s shark loan ponzi finance:

This is how this ponzi scheme works:


Local governmental officials that are demanded from the government to produce double digit GDP growth numbers give real estate developers permits to build housing projects in return for bribes. They also get bribes in return for allowing the shark loan companies to operate under their jurisdiction. Some of them are active partners in shark loan businesses. For example, a party secretary of legal affairs, that controls the public security bureau, which is a court and prosecutor division of government in yongkang city, in zhe jiang province tired to run abroad using a passport in 2009 after he found out he can’t repay 60million Yuan. Every scheme has a ring leader whose job is to collect money from all the participants in the ponzi scheme. When some of these ponzi schemes blow up, the party leaders always get bailed out first, and some even ask local business owners to lend them money, and then bail out their own personal fund. After that the ring leader turns himself in and gets protection from the local government.
Most of the funds that are collected in this classic ponzi finance go to local land purchases and real estate development. Part of the funds is used in order to pay back the rolling loan. The short term interest rate in this black market is very high and ranges between 20%-150% annual rate. The sources of the ponzi funds are diverse, as ordinary citizens, banks with corrupted bank officials, and state enterprises play the game.


The five steps of a fake housing sale in China

1. Before the construction, loan shark operators provide initial finance to small or middle size developers in 2 and 3 tier cities in order to begin the construction.

2. After the construction is complete, and before the official sale to the public begins, loan shark operators will provide resident IDs and other fake documents for mortgage application to real estate developers and make together a fake sale contract.

3. The real estate developer brings the fake contracts to the bank in order to obtain a loan. That can explain why in China, many houses already get sold before they are opened to the public for sale, and why there are so many vacant houses already sold, which no one lives in. (According to the report by Fitch, that was mentioned above there are 64 million unoccupied homes in China)

4. A secret agreement is made between the shark loan operator and the real estate developer. The shark loan operator will get more bank loans through this fake sale, as will the real estate developer. They will use the bank loan in order to engage in another ponzi scheme.

4. The real estate developer shark loan operator will hire people to fake sale frenzy in order to attract real buyers, and if there are enough sales the fake contract will be cancelled out.

5. During the time of the real estate bubble frenzy these ponzi schemes and fake sales were mostly covered, since real buyers could be found. But when the market slows down there will be a thin transaction volume, and the fake sales will be exposed. Then the real collapse will happen.

China’s central government actually knows the massive extent of NPL in the banking system, and they are watching real estate market very closely. All the so called policy action is more of a show off to calm down the angry public than a real measure to tackle the problem. No lethal weapon such as a property tax or an interest rate hike will be used. Simply because the central government knows that they have to maintain the housing prices at a certain level to prevent a panic sale, the will bring down the whole banking system. The train can’t be stopped and it is heading towards a very big wall.

China’s”China Youth Daily” reviled a case of such fake sales. It happened in Changsha, which is the Capital City of Hunan. It exposed a corporation between a shark loan operator, a real estate developer, loan shark and fake sales, and government officials... In this case, the same housing units have been sold more than 6 times. Read full story HERE